Rock to be reborn as a 'good bank'

Plans were being drawn up this weekend to transform Northern Rock into a "good bank" by injecting up to £10bn into the state-owned lender and hiving off its existing mortgage book.

As the government tried to thrash out the terms of an insurance scheme for Royal Bank of Scotland that could involve the troubled bank issuing non-voting shares, attempts were also being made to turn Northern Rock back into a major player in the mortgage market.

The details were still to be finalised over the weekend amid hopes they could be agreed in time for an announcement this week. Under the scheme being discussed, it is thought that the timetable of loan repayments Northern Rock is due to make will be eased or lengthened, which would free the bank to start offering new loans to homeowners.

The bank's troubled existing mortgage book might also be ring-fenced, to allow all the capital being released into the bank to be used to support new lending. The Newcastle-based lender has already warned it will account for one in every 10 repossessions this year and it has been estimated that as many as a fifth of its customers are in negative equity.

Run by former Barclays executive Gary Hoffman, the lender has already embarked on a strategic review and is scheduled to announce its 2008 figures on 3 March, but it is thought that an announcement about the restructuring of the bank will take place before then.

Chancellor Alistair Darling has already signalled that he believes Northern Rock should be encouraged to step back into the mortgage market. But any change of course would probably require approval from the EU, which oversees state aid granted to banks and other companies.

By pulling out of the mortgage market - which it dominated in the first half of 2007 before the credit crunch started to bite - Northern Rock has been able to repay more than £15bn of the £26bn in taxpayer loans it received when it was nationalised. But in doing so it has contributed to the slump in the supply of home loans, as illustrated by recent data from the Council of Mortgage Lenders showing that the number of mortgages taken out fell to its lowest level in 34 years during 2008. Just over 500,000 mortgages were granted for new home sales over the year, down 49% from 1m in 2007 and the lowest number since 1974.

As the government tries to find a way to reinvigorate Northern Rock, it is also attempting to finalise the asset protection scheme that is intended to insure the toxic assets of HBOS, now part of Lloyds Banking Group, and RBS.

Both banks publish their 2008 figures this week and will be vying to report the biggest losses in UK corporate history. RBS is the guinea pig for the asset protection scheme and is expected to pay an annual bill of at least £4.5bn by issuing shares that do not carry voting rights. It is not thought the government's stake will need to increase beyond 68%.

The bank buying the insurance will still suffer a loss on a percentage of the loans before the insurance takes effect. The Treasury has made it clear that any bank taking the insurance will be subject to conditions, which will, among other things, relate to staff remuneration.